Last Updated on February 1, 2022 by pf team
Since the first ETFs launched in the early 90s, exchange-traded funds have become a staple in diversified portfolios. But ETFs don't just bring diversification.
They can also provide more focused investments. High dividend ETFs are a prime example because they offer a steady income stream in a tax-efficient package.
What is a high dividend yield ETF?
As its name suggests, a high dividend ETF focuses on higher-than-average dividend yields. Think of a dividend ETF as a source of income rather than an investment that doubles or triples in value like a stock might.
The best high dividend ETFs also prioritize stability in the fund's assets. After all, a high yield can also signal a troubled asset.
While other high-yield options are available, like high-yield mutual funds, ETFs can boost investment performance through their lower expense ratios.
ETFs also offer compelling tax advantages, which can be especially important if you're investing in a taxable account because ETFs have fewer taxable events than mutual funds.
High dividend ETFs invest in high-yield stocks and bonds with above-average yields. Like other types of funds, an exchange-traded fund owns the assets while investors own shares in the fund.
ETF investors enjoy a certain amount of diversification because the fund owns many assets. However, high dividend ETFs are less diversified than a broad index fund.
ETFs are also easy to buy or sell because ETFs trade on stock exchanges, which is important to some investors. One thing to watch out for, however, is that high dividend ETFs can have higher expense ratios than index ETFs.
How to pick the best high dividend ETFs?
High yields are key but there are other factors to weigh. Consider these steps when choosing the best high dividend ETFs for your portfolio.
1. Choose an ETF screener
Most online brokerage accounts offer a screener that allows you to search for investments that meet a certain set of criteria. The included screener is often sufficient for many investors. However, some people may also want more functionality. Several paid and free options are available to screen with more options.
2. Sort by yield
It's time to narrow the field. Search for ETFs by dividend yield. If your goal is to find a strong dividend, it's probably best to eliminate low dividends but also very high dividends. An unusually high dividend can be a sign of troubled assets within the fund.
3. Consider the fund's 5-year or 10-year performance
Markets go up and down, so the short-term performance of an ETF may not be meaningful. An ETF with a longer track history of solid overall returns may provide more safety than a newer ETF. However, there are no guarantees in investing.
4. Study trading volume
Some dividend ETFs with great yields and a proven history don't trade often. If you have a long-term investment horizon, this may not concern you. However, because ETFs trade on exchanges, there can be a sizeable spread between the bid and the ask price. The spread can affect your buying and selling prices. It can also affect your ability to exit the position quickly if needed.
5. Compare expense ratios
ETFs usually have lower expense ratios than mutual funds. However, you may still find large differences when comparing the expense ratio of one dividend ETF to another. Some have expense ratios as low as 0.25% while others top 0.6%.
6. Consider investment sector, asset class size, or region
Dividend ETFs often specialize in a certain type of investment. Maybe the fund invests in corporate bonds or maybe it invests in developing countries. Look beyond the yield and examine the underlying investments. Consider whether they match well with your investment strategy.
7. Screen for monthly, quarterly, or annual dividends
Consider dividend frequency when choosing an ETF. Monthly dividends provide more frequent income as well as more frequent opportunities to reinvest. However, quarterly dividends are still common and may be a good fit for your goals. Some ETFs also pay dividends annually, which may not be ideal.
10 High dividend ETFs
Today, you have a wide choice of high dividend ETFs. However, many of the ETFs available are relatively new to the market.
Below are some examples with a 10-year track record. When choosing an ETF, you might also consider options that have a shorter history, like 5 years and take a look at Vanguard funds for more diversity.
Yield source: Yahoo Finance.
REM: iShares Mortgage Real Estate Capped ETF
REM focused over 99% in real estate holdings including REITs, which are real estate investment trusts. The fund's largest holding, at over 16% of assets, is Annaly Capital Management, Inc. (NLY).
Annaly Capital is a New York based REIT that invests in real estate, loans, and mortgage securities. As with many dividend ETFs, REM's long-term returns lag recent performance.
However, REM has a strong yield of nearly 9% and impressive YTD performance. If you're looking for a way to invest in real estate but don't want to fix leaky faucets as a landlord, an ETF like REM might fit the bill.
IDV: iShares International Select Dividend ETF
The Dow Jones Industrial Index is probably one of the best-known indexes in the stock market but IDV doesn't track the well-known Dow.
There are actually several Dow Jones indexes. Instead, it tracks the Dow Jones EPAC Select Dividend Index. This index features high dividend paying investments outside the U.S.
Investments from Europe, Pacific, Asia, and Canada (EPAC) regions comprise most of the fund's holdings, although the fund also invests in similar types of assets in other areas.
IDV is well-diversified, with its largest holding at about 4% of assets. Investments span widely from banking to tech companies, which provides another level of safety.
PSK: SPDR Wells Fargo Preferred Stock ETF
With a strong YTD performance of 16.58%, PSK illustrates how a focused fund can drive outsized returns. However, highly focused funds can also introduce risk.
PSK invests heavily in financial services companies, which make up nearly 90% of the fund's holdings. Another 10% of assets focus on utilities companies.
You'll find many household names in the portfolio, including Allstate, AT&T, PNC, and Citigroup. However, no single holding accounts for over 3% of assets, which helps ensure that one weak stock doesn't have a large effect on overall performance.
PFF: iShares Preferred and Income Securities ETF
Utilities remain a popular choice for dividend investors. PFF stacks the deck heavily in favor of utilities, which make up nearly 60% of the fund's holdings. However, the fund also invests in financial services companies and industrials.
PFF seeks to track the ICE Exchange-Listed Preferred & Hybrid Securities Transition Index. This index measures the performance of select companies traded on the NASDAQ and NYSE.
Up to 20% of the fund's assets may be invested in options, swap contracts, or futures to help the fund track the index more accurately.
EMB: iShares J.P. Morgan USD Emerging Markets Bond ETF
Emerging market bonds offer a profitable opportunity for income investors and EMB lives up to its name by investing nearly 100% of the fund's assets in bonds.
If you're familiar with bond funds, you probably know a bond fund with a yield of over 5% is worth a closer look. Most of the fund's holdings are in U.S. dollar-denominated bonds.
However, the fund may also invest up to 10% in futures, options, or swaps to help track its target index more closely. Many funds focus on U.S. based investments, but EMB can give your portfolio international flair while also paying you a handsome dividend.
PGX: Invesco Preferred ETF
With YTD returns of over 16%, PGX deserves a place on your high dividend ETF shopping list. However, a bond fund with a yield of 5.41% invites some scrutiny.
The fund primarily invests in BBB rated bonds, which are still investment grade, but over 30% of the fund's holdings are BB or B rated bonds, which are below investment grade.
High dividend ETFs can come with some risk but with bond funds you're paid well because the interest rates on lower-rated bonds is high. You can also take comfort in knowing that well-known banking names dominate the fund's top holdings.
EWA: iShares MSCI Australia ETF
We've seen continental Europe and emerging markets among the high dividend ETF choices, but what about Australia? EWA mimics the performance of the MSCI Australia Index, which invests in Australian stocks.
Financial services make up nearly 40% of the fund's holdings. However, EWA also holds significant assets in other sectors of Australia's economy, like healthcare and basic materials.
With a GDP of well over $1 trillion, Australia belongs on every international investor's radar. EWA provides a convenient way to gain exposure to the land down under while also paying a healthy dividend.
PGF: Invesco Financial Preferred ETF
Like the similarly named PGX, PGF also invests in bonds. Whereas PGX holds a small percentage of A, AA, or AAA rated bonds, PGF currently holds none.
Instead, the fund's portfolio includes BBB, BB, and B rated bonds. However, BBB rated bonds make up the largest percentage at 70% of holdings.
Similar to PGX, Invesco's Financial Preferred ETF seeks to track an index and holds assets also held by well-known mutual funds, ETFs, and institutional investors. 10-year returns for the fund are among the strongest in our lineup and new investors can anticipate a healthy dividend of over 5%.
CWB: SPDR Bloomberg Barclays Convertible Securities ETF
CWB places its focus on convertible bonds, which are bonds that can be converted to equity. Like many ETFs, CWB seeks to track an index. Here, it's the Bloomberg Barclays U.S. Convertible Liquid Bond Index.
If numbers tell a story, CWB's story is a happy tale. The ETF shows a YTD return of over 15% and rewards investors with a yield of over 5%.
Sector weighting for the fund leans heavily toward utilities, which make up over 60% of the fund's assets and are known for consistent dividends.
If there's a cloud to this silver lining, it's that less than 20% of the bonds held by CWB are investment quality. However, with equity to back up the bonds, maybe the risk is a fair gamble.
HYG: iShares iBoxx $ High Yield Corporate Bond ETF
You may notice a recurring theme here: bonds. HYG also focuses its investment in bonds, but these bonds of a different sort. HYG takes a walk on the wild side with corporate bonds of a lower quality rating than you might find with other funds.
However, the risk seems to working out for investors. Year to date, HYG boasts a total return of 11.42% and the fund has a current yield of 5.29%.
HYG underscores the importance of knowing what's inside an ETF but also encourages investors to take a measured view of the risk.
Nearly all the fund's holdings are rated BB or below but the ETF has strong trading volume and has rewarded income investors for over a decade.
How to invest in high dividend ETFs?
When you're ready to invest, brokerages like Ally Invest, TD Ameritrade and Merrill Lynch make solid choices as well as offer a wide selection of high dividend ETFs.
However, if you prefer a high-tech approach, robo-advisors like Betterment, Wealthfront, and Wealthsimple can build a customized portfolio based on your investment goals.
Other types of dividend ETFs
- Dividend aristocrats ETFs: The term Dividend Aristocrats refers to select stocks that have increased their dividend once per year for the past 25 years. Several ETFs target these stocks, such as NOBL, WDIV, and SDY.
- Dividend weighted index ETFs: A dividend weighted index ETF refers to an ETF that allocates assets based on the dividend and also tracks an index. For example, the WisdomTree U.S. Total Dividend Fund (DTD) tracks the WisdomTree U.S. Dividend Index.
- Hybrid dividend ETFs: A hybrid dividend ETF may combine the features of a high dividend ETF and dividend weighted ETF as well as those from a dividend aristocrat ETF.
Where to hold high dividend ETFs
Where you hold your dividend ETF depends on your investment goals. However, tax considerations can also come into play.
- Sheltered accounts: A sheltered account like an IRA allows you to grow your balance by reinvesting but without paying taxes every year. In effect, you can reinvest more than with a taxable account. However, IRS rules limit access to your account before age 65 and taxes are due when you withdraw, unless you choose a Roth IRA.
- Taxable accounts: With a traditional brokerage account, you'll pay taxes on dividends each year. The taxes aren't deducted automatically, so you can still reinvest the full amount if you choose. However, you'll have to pay any income taxes out of pocket.
High dividend ETFs FAQs
How is a high dividend ETF managed?
High dividend ETFs can be actively managed or passively managed. Each ETF follows its own criteria that determines which assets the fund buys or sells. Funds also rebalance their portfolios, often on a fixed schedule but sometimes as infrequently as once per year.
Do dividend ETFs have minimum initial investment amounts?
When you buy an ETF, you're buying shares in the ETF and there is no minimum investment requirement by the fund itself. However, individual brokers may have minimum investment requirements to open an account.
Which high dividend ETFs pay monthly dividends?
You can use an ETF screener to find ETFs that pay monthly dividends. Some popular examples of monthly dividend ETFs include HYG, DTD, PSK, and DHS.
Can you automatically reinvest the dividends you receive from a dividend ETF?
Many brokers and ETFs support automatic reinvestment of dividends. However, some do not and trading fees may apply. In other cases, automatic dividend reinvestment is a built-in feature of the brokerage account.
For example, TD Ameritrade offers automatic dividend reinvestment for most ETFs.
What does the total return for a high dividend ETF mean?
The total return for a high dividend ETF refers to both the dividend return and the increase (or decrease) in share price. The dividend yield only tells part of the story.
Dividend ETFs can also gain in value or lose value based on market demand for the fund and the fund's holdings.
Are high dividend ETFs better for taxable accounts or sheltered accounts?
You can use either a taxable account or a sheltered account like an IRA for high dividend ETFs. However, a sheltered account performs offers advantages over a taxable trading account.
With a taxable account, you pay taxes on any dividends you earn for the year, even if you reinvest. With a sheltered account, like an IRA, you can reinvest your dividends without paying taxes until you withdraw from your account.
How can I avoid paying taxes for the dividends I receive from a dividend ETF?
Dividends paid from a dividend ETF are taxable. However, if you invest within an IRA or another type of retirement account, taxes aren't due until you withdraw.
This structure allows you to reinvest your dividends without a tax burden since you aren't paying taxes on dividends each year.
Are high dividend ETFs safe?
High dividend ETFs invest in dozens of assets, and sometimes even hundreds. Spreading out the investment helps to protect your money because it's unlikely that all the fund's assets will fall in value dramatically.
Instead, you're more likely to see most assets held by the fund increase in value, which helps to carry any assets that fall in value. However, market moves up and down are common and can also affect dividend ETFs.
Final thoughts on high dividend ETFs
As with many things in life, if something seems too good to be true, maybe you should look a bit closer. High dividend ETF investments should also follow this rule.
You'll find ETFs with yields over 20%. There's probably more to the story, and it's possible that these are ETFs you should avoid.
However, with a small time investment, maybe you'll find a few good options that pay 5% or higher. By comparison, the S&P 500 historically pays about 2% as a dividend.
By choosing carefully, you can triple that dividend performance while still maintaining investment safety.